10 key terms that every mutual fund investor should know before investing!

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Mutual Funds were invented to make investing easy, so consumers wouldn’t have to be burdened with picking individual stocks.

Scott D. Cook

We have all at some point in time have heard about “Mutual Funds” thanks to the increase in investor awareness efforts taken by Asset Management Companies and AMFI. In this article, we try to brush up our knowledge on Mutual Funds.

So first, what is Mutual Fund?

Mutual Fund is basically an instrument that mobilizes money from investor to Asset Management Companies that in turn invest in different market and securities across asset classes (Equity, Debt, Gold, or Real Estate). Every fund has a pre-defined investment objective which is agreed upon between the mutual fund and the investors.

How do they operate?

Mutual Funds seek investment from the investors at the time of New Fund Offer and invest into securities based on the investment objective. The mutual fund earns various income or losses after having invested in securities. Some of them include

+Interest Income

+Dividend Income

+/- Realized Capital Gains/Losses

+/- Unrealized Gains/Losses

– Scheme Expenses

Type of Mutual Funds

EquityDebt HybridGoldReal Estate
Large Cap FundsGILT FundsDebt oriented Hybrid FundsGold Mutual FundsReal Estate Mutual Funds
Midcap FundsCorporate Bond FundsEquity oriented Hybrid FundsGold Sector FundsReal Estate Investment Trust (REITs)
Smallcap FundsShort term debt FundsBalanced FundsGold ETFs
Multicap FundsLiquid FundsCapital Protection Funds
Diversified FundsUltra short term FundsArbitrage Funds
Sector FundsIncome FundsMonthly Income Plan
Thematic FundsJunk Bond Funds
Strategic FundsFixed Maturity Plans
ELSS FundsDynamic Debt Funds
Global FundsFloating rate Funds
Below are the 10 terms that every investor should know about before investing.

New Fund Offer

A mutual fund scheme when it is first available for investment is the New Fund Offer. The asset management company decides to take the scheme to the market and attract investments for its fund. There are two important aspects to it, one is the NFO open date and the other one is the close date.  Investors can invest in the NFO within this time period.

Net Asset Value (NAV)

It is the market value of each unit of the scheme. It is calculated by adding all the income both realized and unrealized and subtracting losses (both realized and unrealized) and expenses. The result is then divided by the number of units outstanding for the fund.  NAV is on a published daily basis and investors can invest in these funds at the prevailing NAV price.

Open-Ended / Close Ended / Interval Funds

Open-ended funds are where investors can purchase units of the fund at any given point in time even after the NFO. On the other hand, close-ended funds have a fixed maturity stipulated opening and closing period (the NFO date) in which investors can purchase units. Interval funds are a mixture of both open and close as these funds are open on a periodic basis for buying and selling at predefined intervals.

Regular / Direct Funds

Mutual Fund schemes offer two main plans for investors to invest in the scheme. One is Direct and the other is Regular. Direct plan as the name suggests is for investors who directly invest with the AMC itself. In other words, there is no distributor (Brokerage Companies or any intermediaries) involved. These funds have lower expense ratio as there is no distribution expense. Regular plans are where investors invest through a distributor and therefore the expense ratio is slightly higher as it involves distribution expense.

Scheme Information Document (SID) / Scheme Additional Information (SAI)

SID is one of the most important documents that consist of all the information related to the fund you are investing. These are easily available on AMC’s website. SAI offers additional information about the AMC that is offering the fund. It includes information about the Sponsor, AMC, Custodian and Trustee of the fund. Both the information in SID and SAI are summarized in Key Information Memorandum (KIM).

Dividend payout / Dividend Reinvestment / Growth Option

Every mutual fund scheme offers mainly two main options one is Dividend payout and the other is Growth. There are some schemes that offer the third option that is Dividend Reinvestment. So, Dividend payout as the name suggests is that the fund whenever it earns certain income, its NAV increases and from the NAV it distributes a certain amount to the investors and investors receive the money into their bank account. The same amount is then deducted from the fund’s NAV.

Second is the Dividend reinvestment option, in this case whenever a scheme makes money it declares a dividend, however, it is not paid to the investor but it is reinvested into the same scheme and investor receives additional units of the fund. The third one is simple which is the growth option wherein there are no dividends declared and an investor can redeem the units at the prevailing NAV price. The returns in all three options can differ widely and tax implications would also be different in each of the options.

Expense Ratio

The fund has a number of expenses including management fees, administrative cost, marketing and distributor expense. The expense ratio is the annual fee charged by the AMC to the investor. Of course, there are limits in place set by AMFI for expense ratio that depends upon the size of the fund. It is needless to say that the lower the expense ratio the better it is for the investor.

Entry Load / Exit Load

Entry Load is a fee collected by the AMC when the investor wants to invest in the fund. Fortunately, AMFI has banned AMCs for charging any entry load to investors. Exit Load is a small fee charged by AMC when the investor exits or redeems their units. It is usually calculated as a percentage of NAV. It depends upon the fund about what the exit load should be, however the longer you hold the exit load is usually lower or even nil certain cases.

Association of Mutual Funds in India (AMFI)

People are often mistaken that AMFI is the regulatory body for mutual funds, which is not the case as SEBI is the regulatory body for mutual funds. Its aim is to develop the mutual fund market in India and improve the ethical and professional standards in the industry.

Factsheet

Mutual Fund releases the factsheet on a monthly basis for every fund that the AMC handles. It includes vital information such as top holdings of the fund, sector allocation, asset allocation, fund performance vis-a-vis benchmark, minimum investment amount etc. Every investor holding any scheme should go through their fund factsheet regularly.

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